The Fraud Triangle
Have you ever heard of the “80/10/10” saying? It suggests that
10 percent of the population is honest; they will not lie, steal or
cheat under any circumstances. Another 10 percent of the
population is dishonest and will participate in criminal activities
whenever they can. The remaining 80 percent, given sufficient
pressures and the right opportunity may behave unethically.
This is the first in a series of newsletters dealing with fraud,
internal control and fraud awareness, and proper use of system
internal controls, especially workflow. This newsletter deals
with why someone steals.
Fraud encompasses a variety of irregularities and illegal acts
characterized by intentional deception. There are various types
of fraud including theft of assets, time, money, and supplies;
fraudulent financial reporting; and misappropriation of assets.
To better assess risk, and prevent and detect fraud, it is
important to understand what motivates people to commit fraud.
The FRAUD TRIANGLE illustrates the three basic elements
that allow fraud to occur.
April 2011
The second element of the fraud triangle is PRESSURE.
Desperate people do desperate things. Pressure comes in many
forms, both financial and non-financial. Individuals may have
personal financial issues such as high medical bills or past-due
mortgages. Others gamble or have addictions that may compel
them to commit fraud. For some, it is simply the desire for a
lifestyle they couldn’t afford otherwise. Lastly, unrealistic
goals and deadlines can also provide incentives for employees
to commit financial reporting fraud.
The final fraud triangle element is RATIONALIZATION.
Rationalization occurs when an employee justifies why they
commit fraud. For example, a person who faces losing their
home might say “I deserve to have a nice home.” Employees
who have not received pay increases might say “I’m just making
up for being under paid. I haven’t had a raise in years.”
Sometimes, an employee will rationalize theft as “borrowing.”
Other times, individuals may believe that “the company
deserves it” for the way they treat customers or employees.
Strong fraud prevention procedures are more important than
fraud detection; because by the time most organizations detect a
fraud, they have already suffered financial loss and damage to
their reputation. While management can take some steps to
reduce pressure on employees, it cannot control all pressures or
prevent rationalization. Opportunity is the key fraud triangle
element which management can control.
The COSO internal control framework provides a foundation
for fraud prevention and detection, and its implementation is
one of management’s best tools to minimize opportunity. The
framework consists of:
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The first element needed for fraud is OPPORTUNITY.
Simply put, it’s the ability to commit fraud. Employees have
the opportunity if they have access to assets and information
that allows them to conceal their fraudulent activities. While
employees need access to perform their jobs, that access can
provide the employee with opportunity.
Committing fraud through use of one’s position normally
happens when internal controls are weak or nonexistent, or
where there is poor management oversight. Opportunities to
commit fraud can increase due to layoffs and staffing shortages
when they weaken or eliminate internal controls.
Control environment – organizational tone
Risk assessment – risk identification and analysis
Control activities – policies and procedures
Information and Communication – information flow
between management and employees
Monitoring – ongoing and periodic assessments
Today’s economic environment may increase pressure and
rationalization. To protect their organization, management
needs to be vigilant in reducing fraud opportunities. Processes,
procedures, and controls should be in place so that employees
do not have the ability to commit fraud.
Is your organization doing enough to prevent and deter fraud?
Don’t wait until a fraud occurs to evaluate your controls. It will
definitely be too late!
Previous topics are available at our website at http://www.apa.virginia.gov/articles.cfm
Contact information can be updated through e-mail to chardon.jones@apa.virginia.gov